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Answers To Common Business Valuation Questions
As business valuation is key when making important decisions involving value. An incorrect value can lead to a failed sale or acquisition, buy-out, tax filing, partnership establishment, or dispute resolution.
Nothing, financial professionals use these terms interchangeably. But they are both opinions of value. You must be sure to understand the scope of analysis and level of report that the analyst will provide, regardless of what they call it.
The word “value” by itself is not specific enough when it comes to business valuation. Different standards of value are used, depending on the purpose and use of the business valuation, and even sometimes the applicable legal jurisdiction. The following standards of value are commonly used to establish the economic value of privately held business interests:
Fair Market Value is usually defined as the price at which a business would change hands between a willing buyer and a willing seller when the former is under no compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. FMV is used for income and estate tax purposes. In the U.S., FMV is the most widely recognized and used standard of value in business valuations.
Fair Value is a statutory standard, usually used in court cases involving dissenting shareholders, shareholder oppression, divorce and other litigation. Its definition and application varies by type of case and jurisdiction.
Investment Value is the value to a particular buyer or investor, based on their specific investment requirements and expectations, and may consider expected synergies when the businesses are combined. Investment value is often used in mergers and acquisitions.
Book Value is not a standard of value. It is an accounting concept. Due to the nature of the accounting process, book value would equal economic value only by chance!
Before an appraiser can value a business, the appropriate standard of value must be ascertained. In a dispute setting, for example, an incorrect standard of value would cause the valuation result to be dismissed altogether.
Yes, it is our policy to never divulge anything about our engagements unless we’re officially directed otherwise. We are bound by non-disclosure agreements, and we can be retained by your attorney to provide client-attorney privilege.
Absolutely, with no vested interests and no hidden agendas.
Our team has expertise in valuing:
- Stand-alone businesses
- Subsidiaries, divisions, profit centers and reporting units
- Entire businesses and fractional interests
- Operating and holding companies
- Corporation, sole proprietorship, family limited partnership, and limited liability company interests
Our broad base of experience and research capabilities allow us to value almost any type of business. We have extensive experience in the manufacturing, e-commerce, healthcare, distribution, services, professional practice, retail, construction and transportation sectors.
Yes, common intangible assets are customer and supplier contracts, license agreements, franchise rights, non-compete agreements, copyrights, designs, goodwill, technology, software, trade names, intellectual property, trademarks, patents, copyrights, trade secrets and Proprietary method or technology. Intangible assets are non-physical assets (as distinct from physical assets) that confer rights, privileges and economic benefits to the owner.
Limited Liability Companies (LLCs)
Limited Liability Partnerships (LLPs)
Yes. If the IRS audits a gift, the burden of supporting the value of the gift is on the taxpayer. A qualified business appraisal (certified appraisal) demonstrates to the IRS that shares are properly valued. See your CPA for advice.
A family limited partnership (FLP) is a business entity established to hold business or financial assets of a family. FLPs provide a number of advantages including centralized management, protection from creditors, and the ability to apply valuation discounts to the partnership interests for estate and gift tax purposes.”
Yes. We will need to review your buy-sell or shareholder agreement, if you have one. A buy-sell agreement controls how ownership interests in a company are transferred. If you don’t have one, we can still value your interest, but the appropriate standard of value will need to be agreed upon.
Generally speaking, equity refers to the debt free valuation of the invested ownership of a company.
An approach is a general way of determining value for a business, business ownership interest, security or intangible asset; using one or more business valuation methods.
The Asset Approach, also called the cost approach, is based on the value of a company’s underlying assets and liabilities, and is generally an indication of the value that has accumulated over time. Generally speaking the cost of duplicating or replacing each component is determined, sometimes using specialist appraisers (e.g. real estate, machinery and equipment). Common asset-based methods are a) Adjusted Book Value Method (sometimes augmented by the Excess Earnings Method to value intangibles), b) Replacement Cost Method, and c) Liquidation Value Method. Liquidation value is the amount that could be obtained from a piecemeal sale of business assets when carried out in either an orderly or forced manner.
The Market Approach is based on the principle of substitution, meaning that for any investment an investor considers, there exist other investments with similar characteristics that are acceptable substitutes. Prudent investors will not pay more for something than they can pay for an equally desirable substitute. Since the objective of an appraisal assignment is usually to arrive at an opinion of market value, it is logical to examine values determined and tested in the marketplace. Two common methods within the market approach are: a) Guideline Public Company Method; and b) Direct Market Data Method.
Essentially, public comparable methods involve pooling together a list of relevant comparable companies, calculating metrics including but not limited to EV/Revenue, EV/EBITDA, P/E, computing the median/average of them and applying it to relevant profitability metric of the company being valued.
We use completed private transactions to evaluate the enterprise value for a private company. We use databases to find these transactions. Similarly to public comps, we compute relevant comps and applying it to relevant profitability metrics to arrive at the firm enterprise value.
The Income Approach considers the earnings capacity of a company. It values a business based on the present worth of the expected future benefit stream, adjusted for risk. Because estimating the future financial performance of a business is speculative, historical data is considered (though not entirely relied upon), on the premise that history often repeats itself. Two common methods within this approach are the Single Period Capitalization Method and Multi-Period Discount Method (discounted future cash flows method). The time value of money describes the idea that investors can gain a general return by investing their cash over time. Therefore, you would place a higher value on the same amount of cash today than in the future.
For example, would you receive a $100 today or a $100 in a year assuming there is a risk-free investment of 3%? Investors could invest their $100 today and yield $103 in a year, so it doesn’t make sense for them to select the latter option. To make these decisions equivalent, you would have to discount $100 by the return you could have made in the investment period (3%).
100/1.03 = 97.09
As seen by the example above, $97.09 would be equivalent to receiving a $100 in year 1 assuming a 3% return.
$103 in year 1 would also be equivalent to receiving $100 today (year 0).
In conclusion, when looking at the future cash flows of a company, we care about how much the cash is equivalent to us in year 0 discounted by an opportunity cost of capital (3% in the given example).
Similar to the preceding discussion concerning standard of value, selecting a premise of value has a substantial effect. There are two basic premises: a) value as a going concern and b) value in liquidation. A premise is normally chosen based on the highest and best use of the business, given the circumstances and market conditions on the date of business valuation. A going concern premise usually assumes that a company will continue in business in a similar manner as conducted in the past, and is based on a company’s ability to generate earnings. According to USPAP, Standards Rule 9-3, in developing an appraisal of an equity interest in a business enterprise with the ability to cause liquidation, an appraiser must investigate the possibility that the business enterprise may have a higher value by liquidation of all or part of the enterprise than by continued operation as is.
A minority interest in a company may be considered less valuable than a non-controlling interest because the minority interest holder can’t control policy setting, payment of dividends, compensation, investment in and disposition of assets, strategic direction and operational aspects of the company. Investors generally pay more for the rights, liberties and benefits afforded a controlling interest, versus a non-controlling interest. A Discount for Lack of Control (DLOC) is a percentage deducted from the pro rata value of a one hundred percent (100%) equity interest in a business to reflect the absence of some or all of the powers of control.
Valuing stock in a private company requires assessing the degree of marketability (liquidity) of the shares in question. Unlike public company securities that have an organized marketplace and are convertible to cash within a few days, most closely held stock is more difficult to sell. A lack of liquidity increases an investor’s required rate of return because it either increases the holding period of the investment (and therefore exposure to changing market conditions) or the cost to convert it to cash or both. Research supports the view that lack of liquidity of privately held securities has a significant impact on value. An ownership interest is not simply marketable or non-marketable (liquid or illiquid). There are degrees of marketability and the appropriate Discount for Lack of Marketability (DLOM) will depend on the facts and circumstances affecting the specific interest being valued and requires careful study.
No, but we may refer you to a qualified real estate appraiser or provide a real estate appraisal if the company we appraise owns or leases real estate from a related party.
We value investment companies (usually family limited partnerships) that hold real estate assets. We also value fractional stakes in these companies at appropriate discounts, but we do not directly value fractional undivided interests in real estate. Contact us for more information.
No. We are not auditors and do not prepare tax returns. Our focus is expert valuation and transfer of private company investments.
Maybe. We have the utmost respect for the accounting profession and most CPA’s do an excellent job with taxes and accounting; however very few (<2%) have the expertise and credentials to value businesses. Most CPA’s won’t appraise their own clients’ businesses even if qualified to do so because they have an inherent conflict of interest. More often, CPA’s ask us to appraise their clients’ businesses, and supply us with the quality financial reporting we need to do the valuation.
No. Some people wrongly perceive business valuation services as a commodity that yields identical results regardless of the valuation provider. However, training and experience matter a great deal, as does the scope of analysis and depth of research conducted, among other factors, and all business valuation outcomes are not identical.”
Value is an opinion not a fact. Whether or not a business valuation withstands the scrutiny of a partner, investor, regulator, lender or judge, as the case may be, depends on the credibility and skill of the individual offering the opinion. Selecting a certified professional increases the likelihood that a valuation will be accepted by your intended users. Before you hire a business appraiser, understand his or her credentials and experience.
Major business valuation credentials in the U.S. are (alphabetically):
ABV – Accredited in Business Valuation, from the American Institute of Certified Public Accountants (AICPA)
ASA – Accredited Senior Appraiser, from the American Society of Appraisers (ASA)
CBA – Certified Business Appraiser, from the Institute of Business Appraisers (IBA)
CVA – Certified Valuation Analyst, from the National Association of Certified Valuators and Analysts (NACVA)
The cost of a given business valuation depends on the level and difficulty of the valuation. Factors include 1) the intended use and users, 2) the scope of analysis and report necessary, 3) the nature and complexity of the business and make up of its assets, 4) the specific business interest being valued, and 5) access to and the quality of information available. It can take many hours to analyze a company appropriately, develop a financial forecast, apply the correct valuation methods, make a final determination of value and prepare a sufficiently detailed report. The appropriate level of service can be determined during our initial meeting. Exit Your Way’s fees are fair and competitive. Our initial valuation consultation is free.
When you only need an estimate of value for internal use, a limited scope valuation may be adequate. For IRS purposes and shareholder disputes, a certified valuation is needed. When a third party investor will rely on the report, a certified valuation is usually appropriate. We will make a recommendation after our initial conversation.
A certified business valuations generally take 10-15 business days from our receipt of the information we need from you. Actual time-frame depends on the scope of work, the complexity of the business, the accuracy and completeness of information, workload and other factors. We will often deliver reports on accelerated time frames when required.
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